Special limitation period does not apply in foreign tax imbroglio

By James A. Beavers, CPA, CGMA, J.D., LL.M.

The Fifth Circuit affirmed a district court's dismissal of the taxpayers' refund suit as untimely because their refund claim was not filed within the general limitation period of Sec. 6511(a). The court further found that the overpayment for which they sought a refund was not subject to the special limitation period in Sec. 6511(d)(3)(A) because their overpayment was not attributable to foreign taxes for which a credit was allowed.

Background

Georg and Bernadette Schaeffler filed a joint income tax return for 2002 on Oct. 15, 2003, and later they filed multiple amended returns for 2002. On or around April 10, 2013, they filed a second amended return for 2002 reflecting two changes: a net decrease in the foreign tax credit of $1.6 million and an increase in the minimum tax credit of $6.76 million. The net reduction in the foreign tax credit resulted from changes to their German tax liabilities.

The increase in the minimum tax credit was due to changes the Schaefflers had made in their third amended tax return for 2001. Their original tax return for 2001 showed that they paid only a regular income tax. On or around April 7, 2012, they filed a third amended return for 2001 that reflected a net increase in the foreign tax credit of $5.6 million and a reduction in the minimum tax credit of $3.15 million, which resulted in their being subject to an alternative minimum tax in the amount of $2.5 million. The Schaefflers claimed that the changes in the third amended return for 2001 "did not cause any additional tax liability or payments" for that year. Consequently, the minimum tax credit for 2002 shown on the second 2002 amended return increased by $6.76 million — the sum of the minimum tax credit from 2001 of $2.47 million and the minimum tax credit carryforward from the years prior to 2001 of $4.29 million.

The second amended return for 2002 showed that the net decrease in foreign tax credit of $1.6 million absorbed a portion of the $6.76 million increase in minimum tax credit, resulting in an overpayment of $5.17 million. The Schaefflers requested a refund for this overpayment, but on Jan. 6, 2014, the IRS denied the claim as untimely. The Schaefflers filed suit in district court seeking the refund for 2002

The IRS filed a motion to dismiss in district court, arguing that (1) the refund claim was untimely because it was filed after the three-year limitation period in Sec. 6511(a); and (2) the overpayment was not attributable to the allowance of a foreign tax credit and, thus, the special 10-year limitation period in Sec. 6511(d)(3)(A) did not apply. The district court agreed with the IRS and dismissed the suit. The Schaefflers appealed the district court's decision to the Fifth Circuit.

The law

Sec. 6511 governs the limitation period for filing a claim for refund. Generally, under Sec. 6511(a), a taxpayer must file a refund claim within the later of three years from the time the return was filed or two years from the time the tax was paid. Under Sec. 6511(b)(3), if the refund claim is filed within three years from the time the return was filed, then the refund cannot exceed the portion of the tax paid within the three-year period, immediately preceding the filing of the refund claim, equal to three years plus the period of any extension of time for filing the return (three-year lookback period). If the refund claim is not filed within that three-year period, the refund cannot exceed the portion of the tax paid during the two years immediately preceding the filing of the claim (two-year lookback period).

Sec. 6511(d)(3) contains an exception to the general rule in Sec. 6511(a). Under this exception, if the tax refund claim "relates to an overpayment attributable to any taxes paid or accrued to any foreign country . . . for which credit is allowed against [income] tax," then a special 10-year limitation period applies. The amount of the refund may also exceed the refund amount limits in Sec. 6511(b) by "the amount of the overpayment attributable to the allowance of a credit for the taxes accrued to the foreign country."

The Schaefflers' argument

The Schaefflers' primary argument was that their refund claim related to an overpayment attributable to foreign taxes for which a credit is allowed, so the exception in Sec. 6511(d)(3) applied. Alternatively, they argued that the claim was timely because it was filed within two years from the time the tax for 2002 was paid.

The Fifth Circuit's decision

The Fifth Circuit affirmed the district court's dismissal of the Schaefflers' refund suit. It found that because the Schaefflers' changes in foreign tax liabilities in 2002 reduced their foreign tax credits, the changes were not the cause of their overpayment and that under a plain reading of Sec. 6511(a), the Schaefflers did not make any payments of 2002 tax within two years of filing their refund claim.

Overpayment attributable to foreign taxes for which credit is allowed: Both the IRS and the Schaefflers agreed that the plain meaning of "attributable to" is "due to, caused by, or generated by" and that "attributable to" sets forth a causation requirement, but disputed whether the Schaefflers' overpayment was attributable to foreign taxes for which the credit is allowed.

In their original return for 2002, the Schaefflers elected to claim their foreign tax credit in the year when their foreign taxes accrued, rather than the year paid. Under Sec. 905(c)(1)(A), this election obligated them to notify the IRS if "accrued [foreign] taxes when paid differ from the amounts claimed as credits by the taxpayer," which practically can be done by filing an amended tax return and providing certain other information.

The Schaefflers contended that the changes in their German tax liabilities for 2002 triggered the notification requirement in Sec. 905(c)(1)(A), under which they had to file the second amended return for 2002 and redetermine their U.S. taxes. The redetermination of U.S. taxes involved incorporating a revised figure for their 2002 minimum tax credit, which then resulted in an overpayment. Thus, the changes in their German tax liabilities for 2002 caused the 2002 overpayment, and the 10-year statute of limitation in Sec. 6511(d)(3)(A) applied. The IRS maintained that the changes in German tax liabilities for 2002 resulted in a net decrease in the Schaefflers' foreign tax credit, so the decrease could not have caused the 2002 overpayment.

The Fifth Circuit agreed with the IRS. The court noted that the key phrase in Sec. 6511(b)(3) was "for which a credit is allowed against the tax" and found that the changes in the Schaefflers' foreign tax liabilities in 2002 reduced, rather than increased or allowed, the couple's foreign tax credit for 2002. Thus, the reduction could not have caused the overpayment, and it was not attributable to foreign taxes for which a credit was allowed. Instead, the court found that the increase in the Schaefflers' minimum tax credit caused the overpayment. The court stated:

While the changes in German tax liabilities for 2002 triggered the [Sec.] 905(c)(1)(A) requirement to submit an amended tax return that reported the increase in the 2002 minimum tax credit, [Sec.] 905(c)(1)(A) is merely a notification provision and did not generate the increase in the 2002 minimum tax credit.

The Schaefflers also contended that "but for" the U.S. tax redetermination required by Sec. 905(c)(1)(A), the minimum tax credit carryforward would have instead been carried forward indefinitely to a future year. The court rejected this argument, finding that under the definition of the minimum tax credit in Sec. 53(b), the minimum tax credit would have been absorbed in 2002 regardless of whether the Schaefflers had submitted their second amended return for 2002.

The Schaefflers further argued that the district court's interpretation of Sec. 6511(d)(3)(A) would affect only taxpayers whose returns are "computed without being affected by minimum tax credits." The court stated that there were a "variety of scenarios" to which the section can apply in cases where a change in a foreign tax liability results in an increase in foreign tax credit, rather than a decrease in the credit, as had occurred in the Schaefflers' case. Furthermore, because of the decrease in their foreign tax credit, the court noted that "even assuming that the minimum tax credit for 2002 did not change and affect the amended tax return for 2002, [Sec.] 6511(d)(3)(A) would not apply."

Refund claim within two years of tax payment: The Fifth Circuit found that since the Code does not define "paid," it should be given its ordinary meaning. After perusing some dictionary definitions of the word "pay," the court concluded that the plain meaning of "tax was paid" in Sec. 6511(a) is "that money was transferred to satisfy a tax liability." According to the court, based on a plain reading of Sec. 6511(a), the Schaefflers did not pay any tax for 2002 within two years of filing their refund claim for 2002.

The Schaefflers took two stabs at this argument. First, they argued that the processing of the 2001 foreign tax credit and the 2001 reduction in the minimum tax credit in the third amended return for 2001 constituted a payment. The court rejected this argument because the plain language of Sec. 6511(a) indicates that the payment must be of taxes for the year for which the "refund of an overpayment" is sought; that, under Fifth Circuit precedent, offsetting adjustments for a single tax year do not constitute a payment of tax for Sec. 6511(a) purposes; and that the Schaefflers had stated in their complaint that the changes that prompted the filing of the third amended return for 2001 did not cause additional payments.

Alternatively, they contended that the carryforward of the credit from their third amended return for 2001, which offset the 2002 reduction in foreign tax credit, was a payment for Sec. 6511(a) purposes, pointing for support to Dresser Industries, Inc., 73 F. Supp. 2d 682 (N.D. Tex. 1999), aff'd, 238 F.3d 603 (5th Cir. 2001), in which a district court found that the application of a foreign tax credit was a payment under Sec. 6511(a). The Fifth Circuit noted that while it had affirmed the district court's decision in the case, it did not address that issue.

After considering the issue, the Fifth Circuit determined that the district court had erred, and that the application of a foreign tax credit was not a Sec. 6511(a) payment. The court found the district court had misinterpreted two earlier cases, Kingston Products Corp., 368 F.2d 281 (Cl. Ct. 1966), and Republic Petroleum Corp., 613 F.2d 518, 525 (5th Cir. 1980), in which the courts held that a credit of an overpayment under Secs. 7422(d) and 6402(a) was payment of tax to mean that the application of a foreign tax credit that reduces a tax liability is also a payment. Because the Schaefflers had not alleged that they had made an overpayment for 2001 that was credited to them in 2002, and the correct view was that a carryforward of a credit was different from the credit of an overpayment under Secs. 7422(d) and 6402(a), the court found that the Schaefflers' second argument also failed.

Reflections

This case comes down to a question of causality and payment. To the taxpayers, the chain of German tax changes redetermined U.S. taxes revised minimum tax credit overpayment was sufficient to make the overpayment "attributable to" the German tax changes. The Fifth Circuit (and the district court), on the other hand, thought they could look back only one link in the chain, to the revised minimum tax credit, as the cause of the overpayment. The court read "attributable to" as requiring "direct cause," where the taxpayers argued that "inextricably intertwined" causes would meet the "attributable to" requirement.

However, even if the taxpayers had convinced the court to adopt their view of what "attributable to" means, they still would not have convinced the court that the carryforward of a credit equaled a "payment."

Schaeffler, No. 17-10719 (5th Cir. 5/3/18)  

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